What is Disclosure?
Perhaps the least controversial provision to attempt to legally restrict, and control executive
decision making is the concept of disclosure. Disclosure, with regards to remuneration, is the release of information on remuneration structures and their relationship with the performance of the company to the shareholders.63 In doing so, the shareholders of the company gain a greater insight
into the negotiating effectiveness of the board, and by receiving the information; they will be in a position to take appropriate action based upon that information. In the case of the UK currently, this can be through voting during the AGM. As minimal intervention in regulatory control it has been advocated by many who perceive that such interference is all that is required in a free market economy.64This part of the chapter will assess the ability of disclosure requirements to control
executive decision making as an aid to good corporate governance. Theory on the Use of Disclosure
Free market ideology claims that private contracts between shareholders and directors should not be interfered with by law, however for shareholders to make informed decisions as to the viability of directors they must have sufficient information to make informed decisions. The first theoretical debates began in the US in the mid 1960’s with economists such as Stigler,65 Friend66 and Herman
and Robbins Werner.67 They argued that disclosure requirements could lead to efficient financial
62 Directive 2013/36/EU of the European Parliament and of the Council of 26 June 2013 on access to the activity of credit institutions and the prudential supervision of credit institutions and investment firms, amending Directive 2002/87/EC and repealing Directives 2006/48/EC and 2006/49/EC Text with EEA relevance [2013] OJ L 176.
63 Guido Ferrarini, Niamh Moloney, Christina Vespro, ‘Executive Remuneration in the EU: Comparative Law and Practice.’ (2003) ECGI Law Working Paper 09/2003, 14.
64 For Example see Hampel committee at 1.9.
65George Stigler, ‘Public Regulation of the Securities Markets’ (1964) 38 Journal of Business 117.
66 Irwin Friend and Edward S. Herman, ‘The SEC Through a Glass Darkly’ (1964) 37 Journal of Business 382. 67 Sidney Robbins and Walter Werner, ‘Professor Stigler Revisited’ (1964) 37 Journal of Business 406.
179 | P a g e markets and a reduction in capital costs as directors remuneration policies could be scrutinised by shareholders.
The development of disclosure requirements within the UK can be traced back to the work of the investigative committees of the 1990s. Cadbury initially began by noting that shareholders had a role to play in the governance of directors of the company,68 dealing specifically with remuneration
Cadbury purported that the overriding principle should be that of openness. Shareholders were entitled to a full and clear statement of directors' present and future benefits, and how they were determined. It was recommended that in disclosing directors' total emoluments and those of the chairman and highest-paid UK director, separate figures should be given for their salary and performance-related elements and that the criteria on which performance is measured should be explained. Relevant information about stock options, stock appreciation rights, and pension contributions should also be given.69 The theory underlying these decisions being that such
disclosure would strengthen shareholders' control over levels of compensation for loss of office. This initial report was the catalyst for academic debate into shareholder activism as a means of good governance.70 The first report to discuss the potential problems of directors’ remuneration was the
Greenbury report.71 Central to the Greenbury report recommendations were the strengthening of
accountability, and enhancing the performance of directors. This was to be achieved partly through disclosure in an annual report to the shareholders, within this report was to be the company’s remuneration policy, including full disclosure of the elements in the remuneration of individual directors.72 These provisions were ultimately incorporated into the Corporate Governance Code.73
Full disclosure was once again affirmed as the loadstar for executive supervision by the Hampel committee in 1998, Hampel quick to reiterate the non-interventionalist nature of the provisions did not seek to control remuneration,74 and noted that the soft touch approach allowed flexibility that
specific legal restrictions would not have. In his opinion accountability was imperative for business
68 Cadbury Report (n 11) para 3.4 ‘Boards of directors are accountable to their shareholders and both have to play their part in making that accountability effective. Boards of directors need to do so through the quality of the information which they provide to shareholders, and shareholders through the.ir willingness to exercise their responsibilities as owners.’.
69 ibid 4.40.
70 See for example John Lowry, ‘Reconstructing shareholder actions: a response to the Law Commission’s Consultation Paper’ (1997) Comp Law 247, 252, Vanessa Finch, ‘Board performance and Cadbury on corporate governance’ (1992) JBL 581, 586 or Christopher Riley, ‘The American Law Institute’s principle of corporate governance’ (1995) Comp Law 122.
71 Greenbury Report (n 48). 72 Greenbury Report (n 48) 5.5.
73Financial Reporting Council, The UK Corporate GovernanceCode(n 19).
180 | P a g e prosperity, and he purported that disclosure was the most important element of this.75Although he
did note that the disclosure requirements at that time may have led to a disproportionate part of annual reports being devoted to these subjects.76
Internationally there was also a drive for greater transparency, the International Corporate Governance Network (ICGN), issued its recommendations on best practice for executive remuneration in 2003. ICGN recommended the ‘fundamental requirement for executive
remuneration is transparency’. This should include disclosure of base salary, short-term bonuses, long-term incentives, and any other payments or benefits. In 2006 updated ICGN Remuneration Guidelines focussed on transparency, accountability and the performance basis. Alongside this, the Organisation for Economic Co-operation and Development produced its own principles of good corporate governance. Within these the OECD outlined its own recommendations on disclosure and transparency,77 under the provisions it was required that the board produce a remuneration policy
for members of the board and key executives, and information about board members, including their qualifications, the selection process, other company directorships and whether they are regarded as independent by the board.78
Legal Requirements to Disclose
The first provisions that required disclosure of directors’ remuneration can be traced to The Directors’ Remuneration Report Regulations 2002.79 Building on the works of the previous
committees, it was introduced by the UK government to ‘increase accountability, transparency, and performance linkage of executive pay.’80 It was partly in response to widespread perception that
director remuneration practices were generating the so-called ‘rewards for failure’ culture.81 The
regulations required a detailed report on directors’ pay to be produced by the compensation committee82 as part of their annual reporting cycle. The report had to be approved by the board of
directors,83 and also the company had to hold a shareholder vote on the directors’ remuneration
75 ibid 2.10.
76 ibid 1.9.
77 OECD Principles of good corporate governance (2004) at part V
www.oecd.org/dataoecd/32/18/31557724.pdf.
78 ibid at 4.
79 The Directors’ Remuneration Report Regulations 2002, SI 2002/1986.
80 Jonathan Baird and Peter Stowasser. ‘Executive Compensation Disclosure Requirements: The
German, UK and US Approaches’ (PLC Document 4-101-7960, PracticalLaw.com, 23 September 23 2002). 81 ibid.
82 Now the Remuneration Committee.
181 | P a g e report at the AGM. This vote was not binding on the directors and was simply advisory, once again affirming the UK light-touch approach to regulation.
The 2002 Regulations and its report were subsequently integrated into the Companies Act
2006(hereon the 2006 Act), under the 2006 Act s.420 requires the directors of a company to prepare a directors’ remuneration report with its contents outlined under s.421. It is important to draw to attention that, like the 2002 regulations, under s.439 the company is required to give notice to the members of the intention to move an ordinary resolution on the directors' remuneration report for the financial year. This vote once again is not binding on the remuneration committee, or the board generally, it is simply persuasive. This lack of binding power will be investigated further in the chapter.
Shareholder Activism
Disclosure is required to encourage shareholder activism but why? There is a large body of evidence to suggest that shareholder activism forms a strong governance mechanism that would allow boards to overcome certain ‘social-psychological barriers in negotiating with CEOs on behalf of
shareholders.’84 Shareholder ‘voice’ if formalised has the potential to form a significant deterrent to
director risk taking.85 Although it may be argued that as the vote is only advisory it bears no
compulsion for remuneration committees to adhere to it. But in reality it would be tantamount to corporate suicide if a committee chose to ignore the opinions of its shareholders.
It is suggested that a much more transparent and open remuneration policy would be beneficial in resolving the so called ‘agency problem’. Statistical evidence prior to the global financial crisis has shown that there is a correlation between the introduction of more transparent and open
remuneration policies, and a greater correlation of equity release to directors with company performance. The most recent study by Balachandran, Ferri and Maber documented a sample of firms before the enactment of the Directors Disclosure Regulations (2000-2002) and then after (2003-2005). The evidence was quite interesting, it noted that although there was no change in the actual level and growth rate of directors pay. There was a significant increase in the sensitivity of directors cash compensation to negative operating performance and in the sensitivity of CEO total
84 Sudhakar Balachandran, Fabrizio Ferri and David Maber, ‘Solving the executive compensation problem through shareholder votes? Evidence from the UK’ (2008) Harvard Business School accessed at
http://www.london.edu/assets/documents/facultyandresearch/Solving_the_Exec.pdf [accessed on 5 September 2014].
85 Lucian Bebchuk, William Friedman and Alicia Townsend, ‘Written Testimony Submitted Before the
Committee on Financial Services United States House of Representatives Hearing on Empowering Shareholders on Executive Compensation’ (8 March 2007) accessed at
182 | P a g e compensation to negative operating and stock performance.86 So analysing this data it would appear
that it may be purported that it is not the release of equity that is the problem but poorly constructed packages that may ‘reward for failure’. Further evidence of the success of the UK transparency theory of remuneration can be shown by the US attempts to adopt similar provisions. In April 2007 the House of Representatives approved a bill seeking to introduce ‘say on pay’ rules similar to the UK.87 Soon after this, a bill was introduced in the Senate88 by (then) Presidential
Candidate Barack Obama.89 The Bill was passed in 2010 as the Investor Protection and Securities
Reform Act 2010. Further to this the last piece of empirical evidence to investigate the effectiveness of disclosure requirements in the US found a positive correlation between mandatory disclosure requirements, and the focusing of directors towards maximisation of shareholder wealth.90
There is however a body of literature that suggests that increasing shareholder activism may not necessarily have such a strong impact on remuneration decisions, as far back as 1992 the Cadbury Committee warned against allowing shareholders to vote on remuneration.
‘A director's remuneration is not a matter which can sensibly be reduced to a vote for or against; were the vote to go against a particular remuneration package, the board would still have to determine the remuneration of the director concerned.’91
There has been a plethora of academics that have also forwarded such arguments.92 Their
arguments are based on an early 1990’s theory that shareholders prefer to take a much more hands off approach to monitoring the company. This theory suggests that the average shareholder may only hold a very small percentage of a company’s equity, and therefore has very little incentive to interfere because the benefit they are likely to receive will not equal the time and effort they undertake.93 It is purported however that this is simply not true, even in the early 1990’s there had
been incidents of shareholder activism.94 This has grown considerably in the past couple of years
also and will be explored later in the chapter with relation to the ‘Shareholder Spring of 2012.’
86 ibid.
87 Rep Frank Barney ‘Shareholder Vote on Executive Compensation Act’ (H.R. Bill 1257). 88 Sen Barak Obama, (Senate Bill 1811).
89 Reed Walton, ‘U.S. Senate Takes Up "Say on Pay" Bill’ (Riskmetrics, Risk & Governance Blog, 30 April 2007). 90 Michael Greenstone, Paul Oyer and Annette Vissing-Jorgensen, ‘Mandated disclosure Stock Returns, and the 1964 Securities Acts Amendments.’ NBER Working Paper Series working Paper 11478, 33 accessed at
http://www.nber.org/papers/w11478 [accessed on 5 September 2014]. 91 Canbury Committee (n 11) para 4.43.
92 Andrew Griffiths, ‘Directors' Remuneration: Constraining the Power of the Board’ [1995] LMCLQ 372, 373 93 Lee Roach, ‘The Directors' Remuneration Report Regulations 2002 and the disclosure of executive remuneration’ (2004) Comp Law 141.
94 In 1987 the remuneration package of the Burtons chairman, Sir Ralph Halpern was reduced from £8 million to £2.5 million following pressure from institutional shareholders.
183 | P a g e
Responses Following the GFC: Has Disclosure Worked?
Under the 2006 Act, formal disclosure was a legal requirement during the financial crisis, and as a result it is clear that in the future disclosure alone will be unable to stop a future crisis. Nor would one expect it to, however perhaps the more pertinent question to be asked is can disclosure still be an aid to good governance?
It appears that there is still a strong theoretical appetite for directors’ remuneration disclosure requirements within the UK financial system. The Walker Review generally appears to opt to maintain the current norm in regulation. Whilst specifically addressing the disclosure of ‘high end’ remuneration, the Walker Review was reluctant to increase the level of disclosure of formal remuneration. 95 It was noted in particular that working in a global setting it was important not to
adversely hinder UK listed companies against their international competitors.96 Debate did spark
around the publishing of individual director’s remuneration packages,97 however such a provision
was deemed to be too invasive, and largely irrelevant for overall corporate governance. Walker preferred to focus on remuneration committee reports, and to ensure that the committee review performance indicators, as oppose to executives total remuneration, were available to shareholders. Walker concluded that the remuneration committee report should confirm that the committee is satisfied with the way in which performance objectives are linked to the related compensation structures for the company, and explain the principles underlying the performance objectives and the related compensation structure if not in line with those for executive board members.98 This
requirement ultimately forces committees to justify their decision and thought processes. It is purported that this would be far more relevant and important than focusing on individual remuneration figures. Individual headline figures could detract from the overall debate, with shareholders focused too much on the total value of what may be perceived as ‘excessive
remuneration.’ This argument is supported to some extent by the shareholder spring of 2012 and also more recent episodes of shareholder activism.99 Ultimately Walkers final recommendations
relating to ‘high end employees’ included the need to:
‘Disclose the remuneration of employees earning £1m or more. Disclosure should be in bands, noting the number of employees in each band, the areas of business activity in which they are
95 Walker Review (n 10) 7.11. 96 ibid 7.12.
97 ibid 7.11.
98 ibid Recommendation 30.
184 | P a g e involved (where possible) and, within each band, the main elements of salary, cash bonus, deferred shares, LTIPS and pension contributions.’100
These recommendations have been affirmed by other organisations such as the Financial Stability Forum101, under their Principles for Sound Practice102 the FSF noted that ‘Firms must disclose clear,
comprehensive and timely information about their compensation practices to facilitate constructive engagement by all stakeholders.’
Binding Vote on Disclosure
Following the financial crisis; BIS consulted on the reform of the remuneration system as a whole, it considered proposing even greater transparency through disclosure.103 This culminated in a
proposal104 for all listed companies to include an annual binding vote on the company's future
remuneration policy. This deferred significantly from the previous light touch approach as it allowed direct shareholder opinion to be taken account of. It also required an increased level of support for votes on future remuneration policy (beyond what was previously a simple bare majority) and an annual advisory vote on how remuneration policy was implemented in the previous financial year. Finally it also required a binding vote on exit payments above one year's salary. These proposals were ultimately taken on by the legislature and inserted into cl.57 of the Enterprise and Regulatory Reform Bill, introduced into the House of Commons on May 23, 2012.
The Bill came into force as the Enterprise and Regulatory Act 2013. Amongst other things the intention of the act was to increase transparency, to ensure greater understanding of the link between pay and performance. The main intention of the act was to introduce a binding vote on general pay policy that will be explored in the next part of the chapter. However alongside the act, was the introduction of a piece of regulation that questions the current theories of executive control. The Large and Medium- sized Companies and Groups (Accounts and Reports) (Amendment) Regulations 2013, the intention of the regulations is to make it much easier for shareholders to find and identify the information that is required under disclosure. Possibly the most contentious provision under the regulations is that the report now requires a single total figure of remuneration for each director. 105 Under the Regulations
a committee is required to publish not only the total amount of remuneration for each director, but
100 Walker Review (n 10) Recommendation 31. 101 Now the Financial Stability Board (FSB).
102 Financial Stability Forum, ‘FSF Principles for Sound Compensation Practices’ (April 2009). 103 BIS, Executive Pay: Shareholder Voting Rights Consultation’ (March 2012).
104 BIS consults on enhancing shareholder voting rights over directors' remuneration (2012) 313 Co. L.N. 1. 105 Large and Medium-sized Companies and Groups (Accounts and Reports) (Amendment) Regulations 2013 s.4(1).
185 | P a g e also the total amount of salary and fees;106 all taxable benefits;107 and perhaps most importantly,
money or other assets received or receivable for the relevant financial year as a result of the achievement of performance measures and targets.108 Therefore it is clear that each individual
director’s salary is now being placed up for scrutiny as a result of the regulations. This will have a significant impact on voting practices during subsequent AGMs. The disclosure of individual remuneration packages for directors is in direct conflict with the wishes of Walker and the other post GFC reports.
As an exercise it is interesting to note that the UK government also released a further Companies' Remuneration Reports Bill 2009109 this bill intended to make alterations to the Companies Act 2006,